Ark Restaurants Corp. (ARKR) is a company operating in the restaurant services industry and, in my perspective, is a "hidden" prospect ready for substantial growth on the basis of its current valuation, low level of firm-specific risk, and strong business model to continue operations in some of the highest population density locations in the U.S. In this first part of investment analysis, I will provide an overview of ARKR's business and historical performance, then outline the valuation criteria that makes ARKR a strong value play, and conclude with both discussing risk metrics lying within ARKR's holding period returns as well as laying out potential risk investors should take into account.
ARKR is a corporation headquartered out of New York that owns and operates three different types of establishments including restaurants, bars, and fast food concepts. In addition, ARKR provides specialized catering services through its subsidiaries. Originally, operations were specific to the New York City area; however, ARKR now owns establishments across seven different regions in the U.S.:
- New York City
- Washington D.C.
- Las Vegas, Nevada**
- Atlantic City, New Jersey**
- Boston, Massachusetts
- Ledyard, Connecticut**
- Hollywood & Tampa, Florida**
According to ARKR's 10-K for FY 2011, ARKR owns and operates 22 restaurants and bars as well as 28 fast food concepts spread throughout the locations specified above. Locations where all establishments and services are located at casinos (denoted above with asterisks) are four out of the seven locations.
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Figure 1: ARKR 5-Year w/Dividend Distributions
In Figure 1, the graph depicts ARKR's five-year historical performance with its dividend distributions denoted by the small black squares labeled with a "D." Focusing on the 2008-2009 credit crisis, you will notice the company continued to distribute a dividend during a significant decline in market value per share. After bottoming out, it maintained a relatively low market price per share and has had no overly large fluctuations since 2010; hence the reason why there has been little variance in ARKR's holding period returns keeping the standard deviation relatively low (which is supported numerically below in figure 5). In addition, this graph does a good job of showing the strong support line that has developed over the past three years.
Figure 2: ARKR YTD
The graph above displays ARKR's most recent performance from YTD. The strongest, most current support line the stock has developed is roughly in the $14.25-$14.50 range, which I depicted with the blue trend line. ARKR is currently trading at approximately $16.50 to $17.00 per share. Having just reached its 52-week high at $17.00, with no notable pull backs, it is sitting at a market cap of about $58.4 million. Overall, as you can tell, ARKR has experienced a nice upward trend YTD, becoming more appealing to investors as operations continue to become more profitable. ARKR has been consistent with its dividend distributions as well, providing investors with an annual yield of 5.92%, $1.00 per share.
Figure 3: ARKR Outperforming S&P and Competitors
Above in figure 3 is a graph I retrieved from Y-Charts displaying ARKR's performance relative to the S&P and two competitors: Dunkin' Brands Group (DNKN) and Tim Hortons (THI). ARKR has clearly outperformed the S&P and its competitors YTD, with THI closely behind. Part II of this analysis will include a comprehensive competitive analysis with the companies shown above as well as Brinker Intl., Inc. (EAT), DineEquity (DIN), YUM! Brands (YUM), and last but not least McDonald's (MCD), which all have significant market share in different segments. The more well known companies such as YUM, MCD, and DIN are the direct competitors in the fast food services portion of their restaurant services. And then a better competitor when it comes to more upscale dining services - the main direct competitor - is EAT, which owns, operates, and franchises the Chili's Bar and Grille and Maggiano's Little Italy restaurant brands.
Value of Equity and Operations
Nearly 58% of ARKR's common stock outstanding is owned by a combination of insiders and institutional investors, with insiders owning approximately 32% and the remaining 26% by institutions. The remaining 42% is owned by individual investors with majority of the owners residing within the U.S. From a current valuation stand point focusing on free cash flows and the value of operations, I estimated ARKR is trading about 22% below fair value. In addition, ARKR has a positive alpha value of 0.171, which is in support of my hypothesis behind its valuation. Taking a look at ARKR's balance sheet, another thing I envy is its very low level of debt outstanding, and historically it has kept debt to a minimal amount. The current level of debt outstanding on its balance sheet is $1.5 million, and it does not show any patterns of issuing preferred equity as a substitute. To evaluate the potential upside for investors, I used the corporate valuation model.
Figure 4: Corporation Valuation Model
The model calculates the intrinsic value of the firm based on the future value of operations by first projecting free cash flows forward. It then uses a modification of the constant growth model with the firm's expected growth rate and weighted average cost of capital estimate. This allowed me to derive an intrinsic share value of 2012 and 2013. Note that by intrinsic share value, I am implying what the firm should be worth by that date given the inputs in this model. For 2012 FY, an intrinsic share value of $19.50 implies a 15.5% upside from current levels and the estimate for 2013 FY implies an extremely high upside of 69.69%.
Firm-Specific Risks: Quantitative and Qualitative
ARKR has a very low firm-specific beta value of 1.2, slightly above the market beta level of 1.0.
Figure 5: Risk Metrics
To analyze ARKR's historical firm-specific risk, I used the holding period returns with distributions for the past three years (October 2009 to October 2012) and I used the same data of SPDR S&P 500 ETF Trust (SPY) as a benchmark for comparison. For accuracy and effort towards eliminating error in computing the sample estimates, I used the same methods in all calculation and retrieved equivalent data with identical number of observations for both securities.
In figure 5, notice ARKR's arithmetic average is 1.56%, substantially higher than the average return generated by SPY over the same time period. The variance in the holding period returns for both securities is dramatically low, indicating that ARKR has a higher probability of outperforming the market, yet providing substantially low risk for a long-term position. If you were to hold ARKR in isolation, it yields a standard deviation of 1.8%, which again is very low. The last measure that yielded favoring results was the correlation measure of ARKR and SPY, which was .08%, indicating that these two securities show an insignificant relationship. Given this correlation measure, it is safe to conclude that ARKR is less sensitive to events that generally cause price fluctuations in SPY and may become more stable at times when SPY tends to rapidly decline.
In addition to the quantitative risk metrics involved with ARKR, there are firm-specific qualitative risk factors that need to be assessed as well. There are many positives and high gains that can be achieved through running operations located at casinos; however, four of their seven regional locations solely base their operations at the casinos. As a result, this could potentially have a negative impact on profitability because of this geographic concentration of solely relying on one group. So far this has not had any notable negative impact on ARKR's business, but is fair that investors are aware of this.
Potential Investor Concerns
Majority of the concerns investors are faced with are external to the firm and are entirely out of its control. Given management continues doing a good job in making decisions that revolve around taking on new projects, targeting new locations of operations, etc., it is going to be most important that external factors do not affect its operations and/or dampen its performance, as ARKR finished Q4 and proceeds into FY 2013, so I have outlined the most critical external factors that could potentially harm ARKR's market value per share.
- Government Regulation - ARKR's operations exist under supervision and regulation of a wide range of local, state, and federal laws.
- Changes in Minimum Wage - ARKR employs nearly 2,000 individuals. Of that figure, roughly 700 are part-time employees. Majority of employees are paid slightly above minimum wage. However, a sufficient number of employees are paid at minimum wage, where a change to this minimum would pose threats of increased labor costs.
- Seasonal Changes - ARKR is extremely correlated with seasonal changes. Excluding days surrounding holidays, the months of January, February, and March typically produce the poorest performance on a quarterly basis.
- Increasing Insurance Premiums - The average price of insurance has historically increased over the past several years and this trend is expected to continue. In relation to ARKR's business for its operations and employees, it requires coverage in the following areas: workers compensation insurance, general liability, property insurance, health insurance and directors and officers liability insurance. In addition, the possible law of state regulation requiring that all employers must provide employees with health insurance would have a negative effect.
ARKR has an excellent business model with a high potential for growth. Although ARKR is trading near the top of its 52-week high, several analysts within the past five days just upgraded ARKR from a hold/buy to a strong buy/accumulate rating. Attractive valuation makes ARKR's 52-week high a bargain. The next article in this series will include an in-depth analysis of ARKR's operations and direct competitors with an emphasis on what to look for in terms of growth. Also, it will include more forward-looking projections going into 2013.
Sources: TD Ameritrade, Google Finance, The Wall Street Journal, ARKR's 10-K from the website for the Securities and Exchange Commission, and Y-Charts.